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Lennar Corporation (NYSE:LEN)

F2Q 2014 Earnings Conference Call

June 26, 2014 11:00 ET

Executives

David Collins - Controller

Stuart Miller - Chief Executive Officer

Bruce Gross - Chief Financial Officer

Diane Bessette - Vice President and Treasurer

Rick Beckwitt - President

Jeff Krasnoff - Chief Executive Officer, Rialto

Jon Jaffe - Chief Operating Officer

Brett Ersoff - President, Rialto Mortgage Finance Group

Analysts

Adam Rudiger - Wells Fargo

Dan Oppenheim - Credit Suisse

Stephen East - ISI Group

Eli Hackel - Goldman Sachs

David Goldberg - UBS

Ivy Zelman - Zelman & Associates

Jade Rahmani - KBW

Rob Hansen - Deutsche Bank

Operator

Welcome to Lennar’s Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

I will now turn the call over to Mr. David Collins for the reading of the forward-looking statement.

David Collins

Thank you, and good morning, everyone. Today’s conference call may include forward-looking statements, including statements regarding Lennar’s business, financial condition, results of operations, cash flows, strategies and prospects. Forward-looking statements represent only Lennar’s estimates on the date of this conference call and are not intended to give any assurance as to actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties.

Many factors could affect future results and may cause Lennar’s actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described in this morning’s press release and our SEC filings, including those under the caption Risk Factors contained in Lennar’s Annual Report on Form 10-K most recently filed with the SEC. Please note that Lennar assumes no obligation to update any forward-looking statements.

Operator

I would now like to introduce your host, Mr. Stuart Miller, CEO. Sir, you may begin.

Stuart Miller

Great. Good morning, everybody. Thanks for joining us for our second quarter update. This morning, I am joined by Bruce Gross, our Chief Financial Officer; Dave Collins, who you have just heard from; and Diane Bessette, our Vice President and Treasurer. Additionally, Rick Beckwitt, our President, Jon Jaffe, our Chief Operating Officer are here as is Jeff Krasnoff, Chief Executive Officer of Rialto. And they will be available for Q&A today as well. Eric Feder isn’t here today, but then instead we have Brett Ersoff who runs our RMF Rialto Mortgage Finance Group. So, he is available also.

Now, as is customary on our conference calls, I want to begin this morning with some brief overview remarks on the housing market and then briefly look at our operations. And then Bruce is going to provide greater detail. As always, we will open up to question and answers. And as in the past we would like to request that we limit ourselves to one question and one follow-up per person, so that we can leave as much time for people as possible.

So, with that let me go ahead and begin. And let me begin by saying that we are very pleased to report another very solid quarter of performance for our company. Our second quarter results demonstrate that our company is positioned to be able to continue to perform extremely well in current market conditions due to a carefully crafted operating strategy. Generally speaking, the market continues a slow and steady recovery that is driven by limited supply of available homes both new and existing that are on the market, limited supply of land available to add to the supply of these homes and constrained demand from purchasers who would like to buy, but are unable to access the mortgage market.

While many investors have been disappointed that the 2014 spring selling season did not have the steep vertical accelerations that had been anticipated, the market did continue to move slowly and steadily forward driving volume upward marginally and still driving pricing upward though at a somewhat slower pace. We continue to believe that the fundamental drivers of improvement in the housing market remain a steadily improving economy with a slowly improving employment picture unlocking pent-up demand while supplies remain constrained to meet that demand. We continue to believe that there remains a production deficit of both single and multifamily dwellings from the underproduction that took place during the economic downturn and up to and including this year and last. This shortfall is likely to continue to define the housing markets for the foreseeable future and will drive the housing recovery forward.

Lennar has begun the first half of 2014 with very solid results as each of our businesses showed strong performance and are well-positioned in the thickest part of the market for continued future performance. The combination of solid management execution of our articulated strategies and strategic investments in core assets have combined to produce strong first half results and will enable continued industry leading performance throughout the year. Homebuilding of course remains our primary driver of quarterly performance. For the second quarter homebuilding revenues grew to $1.6 billion, up 29% over last year, while deliveries were up some 12% over the prior year.

Maximizing our strong land position, we focused on balancing pricing power and sales pace while controlling costs and accordingly we produced 14.7% operating margin, 140 basis points year-over-year increase and the highest second quarter operating margin in the company’s history. Our sales pace in Q2 improved to 3.7 average sales per community per month, up from Q1’s pace of 2.8, but slightly lower than last year’s pace of 4 per community per month. Our average sales price of $322,000 was the year-over-year increase of $40,000 or 14%, this improvement in sales pace covered increases in labor, material and land costs improving our gross margin by the 140 basis points year-over-year to 25.5%.

Our sales continue to benefit from the execution of our NextGen product strategy, year-over-year sales of our multi-generational brand grew by 58% totaling 368 sales in our second quarter. We now offered NextGen plans in 201 communities across the country and in our second quarter the average sales price for NextGen was 39% above the company’s average. We have continued to focus on homebuilding strategy on the move-up segment of the market as the first time home purchaser has not yet been able to access the mortgage market. Nevertheless, we are strategically positioned with both land and product to capture the first time home buyer demand when it is enabled by the mortgage market and it emerges with inevitable strong and pent up demand.

Now complementing our homebuilding operations, our Financial Services segment continued to build its primary business along side the homebuilder and is working to replace the now diminished refi business with additional business across our national footprint. Bruce will talk a little bit more about our Financial Services progress which had a very respectable quarter with operating earnings of $18.3 million, though down from the $29.2 million last year when the refi business was thriving.

While our Homebuilding and Financial Services divisions are the primary drivers of near-term revenues and earnings, our three additional operating divisions are all continuing to mature as excellent longer term value creation platforms for the company. We continue to be very pleased with the progress of our multifamily apartment business. As we have noted in the past this business began operations in early 2011 and is positioned to become one of the leading developers of new Class A apartments in the United States. As homeownership rates have drifted downwards and as mortgage approvals have remained elusive for first time purchasers and as the large millennial generation begins to leave home and form households, this strategy continues to be an excellent complement to our primary for-sale homebuilding business.

During the second quarter, we started development and construction on two additional apartment communities. We now have 17 communities of which two are completed and operating and two are partially completed and starting a lease-up program and the remaining 13 are under construction. These communities have approximately 4,500 apartments with an estimated development cost of approximately $1 billion. In addition to these communities, we have a geographically diversified pipeline that exceeds $3 billion and represents an additional 12,000 plus apartments.

As we have discussed in the past, we are building these apartments with third-party institutional capital and each deal has been conservatively financed with non-recourse debt. With our conservative financing and our conservative underwriting, we are positioned to earn IRRs exceeding 25% and cash multiples greater than two times. And we anticipate that the construction of our development pipeline will be completed over the next four years.

Next, Rialto continues to make significant progress in transitioning from an asset-heavy balance sheet investor to a capital-light investment manager, commercial loan originator and securitizer. The initial direct investments were able to continue to return capital to Lennar in the second quarter and we believe we’ll return over $400 million of cash for us to recycle by the end of 2016.

Our investment management and servicing platform is growing our assets under management and creating value for investors. We are continuing to build upon the base established with our first two real estate funds. Fund II is already – Fund I is already invested or committed. Fund I is already invested and Fund II is already invested or committed to invest almost $800 million of equity in approximately 60 transactions and has started making distributions of income to investors as well. We expect to begin raising our third real estate fund later on this year.

And finally, Rialto Mortgage Finance, our high return on equity lending platform is originating and securitizing long-term fixed rate loans on stabilized cash flow in commercial real estate properties. And we completed our seventh and eighth securitization transactions in the second quarter selling an additional $400 million of RMF originated loans bringing the total to almost $1.3 billion in only our first three quarters of securitization activity. In the second quarter, Rialto exceeded our expectations with operating results of $13.4 million this quarter, reflecting the continued maturity of a three different businesses and its positioning for strong 2014.

Our FivePoint Communities Program continues to make significant progress as well in developing our premium California master plan communities. At El Toro, the first phase of 726 homes is over 75% sold out and the second phase of the 1,000 home sites will be sold to builders around the end of this year or the beginning of next year with a grand opening expected in late spring.

At Newhall Ranch, we won two sequel lawsuits as well as an appeal of a lawsuit challenging our environmental permits this quarter. We expect any appeals to be concluded around the end of the year allowing us to begin development of the first 5,000 home sites there. And in San Francisco, we are opening the shipyard, Hunters Point, where we are pre-selling homes this quarter and will grand open models in August. Currently, about 250 homes are under construction and another 100 are scheduled to start this year. The venture will begin delivering these homes at the end of the year and the bulk of them delivering in 2015. Lastly, at Treasure Island, we are designing and processing land development engineering with an expectation to break ground in early 2016.

Overall and in summary, our company is extremely well-positioned to succeed in current market conditions. We have an excellent management team that’s focused on a carefully crafted strategy that’s positioned us with an advantaged asset base that will continue to drive industry-leading profitability. Additionally, we have a well-diversified platform that will continue to enhance shareholder value as our ancillary businesses continued to mature. We are very pleased with our progress and performance and we are very pleased with the progress and performance in the second quarter and look forward to reporting our progress in our third quarter soon.

With that, let me turn over to Bruce.

Bruce Gross

Thanks, Stuart and good morning. Our net earnings for the second quarter were $0.61 per diluted share. The prior year’s earnings per share included a partial reversal of the state deferred tax asset valuation allowance of $0.18 per diluted share. The prior year’s EPS would be $0.43 after excluding the $0.18. Revenues from home sales increased 28% in the second quarter driven by a 12% increase in deliveries and a 14% year-over-year increase in average sales price to $322,000.

In our earnings press release, we added additional disclosure by including average selling price by region. Please refer the press release tables to see this data. Our gross margin on home sales was 25.5% compared with 24.1% in the prior year. That’s the 140 basis point improvement that Stuart mentioned. Sales incentive improved by 80 basis points versus the prior year to 5.9% as a percent of home sales revenue or $20,300 per home delivered in the second quarter. Additionally we had $9.6 million of insurance recoveries and other non-recurring items which added 60 basis points to the gross margin percentage for the quarter. The gross margin percentage for the quarter was highest in the East, Southeast Florida and West regions.

Selling, general and administrative expenses as a percent of revenues had additional leverage and improved 10 basis points to 10.8%. And with the improvement in both gross margin and SG&A our operating margins improved again up 140 basis points to 14.7%. In addition to this significant operating margin leverage we have also recognized operating leverage in our corporate G&A line which improved 30 basis points to 2.1% as a percentage of total revenues.

Other interest expense declined from $25.1 million in the prior year to $10.3 million in the current quarter as we continued to open communities and increase the qualifying assets eligible for capitalization. This quarter we opened 95 communities and ended the quarter with 579 net active communities. We purchased 5,800 home sites during the quarter totaling $379 million. Our home sites owned and controlled now total 164,000 home sties.

Turning to Financial Services, our Financial Services business segment delivered operating earnings of $18.3 million versus $29.2 million in the prior year. This is consistent with our previous guidance that Financial Services profitability would be lower due to a more competitive environment as a result of a significant decrease in the refinance transactions. Mortgage pretax income decreased to $16.7 million from $26.1 million in the prior year. Refinance originations declined 63% from the prior year. However, we were able to replace this loss volume with additional purchase originations to end the quarter with flat year-over-year origination volume at $1.4 billion. Although the volume is flat the heightened competitive pressure has reduced the profit per loan.

Our in-house capture rate of Lennar homebuyers was 77% this quarter and our title company had a $2.2 million profit in the quarter compared with the $3.7 million profit in the prior year. The reduction was primarily due to lower volume. Our Rialto business segment generated operating earnings totaling $13.4 million compared to $2.8 million in the prior year. Both amounts are a net of non-controlling interest. The composition of Rialto is $13.4 million of operating earnings by the three types of investments and these are before G&A expenses and Rialto interest expense are as follows.

First, the investment management business contributed $28.4 million of earnings. This includes $17.9 million of equity and earnings from the real estate firms and $10.5 million of management fees and other. These numbers don’t include the carried interest which under a hypothetical liquidation increased by approximately $14 million for the quarter and is now at $104 million for Real Estate Fund I. Second, our new Rialto mortgage finance operations contributed $438 million of commercial loans into two securitizations resulting in strong earnings of $18.5 million for the quarter. Third, our liquidating direct investments and again these are the remaining assets in the FDIC and bank portfolios had a net loss of $1.6 million. This included our share of losses in the FDIC portfolio totaling $11.3 million which was primarily due to the share of impairments in the portfolio as a result of loan extensions and modifications extending and reducing the collections while partially offset by higher collections and gains on sales and the bank portfolios.

Rialto G&A and other expenses were $24.3 million for the quarter and interest expense was $7.5 million. Rialto’s balance sheet had a strong liquidity position with $245 million of cash at quarter end. Multifamily results for the quarter are consistent with our expectations as we have net startup expenses of $7.2 million.

Turning to our balance sheet, our balance sheet liquidity is strong. We ended the quarter with $638 million of homebuilding cash balances and no outstanding borrowings under our $950 million unsecured revolving credit facility. Yesterday, we announced that we completed an amendment to our credit facility increasing our facility to $1.5 billion, which includes $263 million accordion feature. The amendment increased our borrowing capacity and provided more flexible covenants while lowering our borrowing costs. We appreciate the support from the 17 banks in our facility. This revolver increases availability and coupled with our confidence in strong earnings power going forward enables us to continue to deploy more of the cash earning low returns on our balance sheet into high return investments. Our homebuilding net debt to total capital was 48%. Stockholders’ equity grew by 23% year-over-year to $4.4 billion this quarter. Our book value per share increased to $21.52 per share.

There are three adjustments I would like to highlight in our 2014 goals. Number one, deliveries, we are maintaining our goal to deliver between 21,000 and 22,000 homes for 2014. However, we are adjusting our backlog conversion ratio expectations between Q3 and Q4. We are adjusting Q3 to between 75% and 80% backlog conversion ratio due to the first quarter weather delays pushing some home completion dates into the fourth quarter. However, as a result, we are increasing our expected conversion ratio for the fourth quarter to between 95% and 100% conversion of the backlog. Second, gross margins we continue to expect our gross margins in 2014 to average 25% for the full year. And this excludes the insurance settlements highlighted in both the first and second quarter. We expect the third quarter to be in the high 24% range, while the fourth quarter should be just slightly over 25%.

Turning to Rialto, we expect a range of profits still in the $30 million to $40 million range for the year. We expect a similar trend as we look at the second half of this year to the prior year with the third quarter delivering lower profits than the fourth quarter. We expect the timing of our Rialto Mortgage Finance securitizations to be more heavily weighted to the fourth quarter.

And let me just reiterate the reminder of our previously stated goals for 2014. We continue to expect approximately 25 basis points of potential improvement for SG&A for all of 2014 over 2013. Financial Services is still expected to be in the range of $65 million to $75 million of operating earnings. Our multifamily operations are still expecting startup losses of $15 million to $20 million, which includes one or two apartment community sales later this year. We are not expecting any significant joint venture or land sale activity in 2014 and these categories should be about breakeven. We haven’t changed our tax rate expectations for the year at 37% and our net community count is still expected to end the year in the range of 600 to 625 communities.

With that, let me turn it over back to the operator for any of your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. Please limit your questions to one question and one follow-up. (Operator Instructions) Our first question comes from Adam Rudiger from Wells Fargo. Go ahead sir. Your line is open.

Adam Rudiger - Wells Fargo

Hi, good morning. Thanks for taking my questions. I was wondering if you could talk about community count by segment a little bit and just saw some of the trends there, you had some pretty divergent absorption paces across your different segments, so I just wanted to try to understand what was occurring in those a little bit better?

Jon Jaffe

Hi, it’s Jon Jaffe. We saw our community count growth the greatest in California and Texas, followed by Nevada and Colorado and it was a little slower this quarter in the East and then our Houston regions.

Adam Rudiger - Wells Fargo

Okay. And then second question was on incentives, they have been relatively flat for four quarters in a row now roughly 6%ish, do you think that’s where they will stabilize or do you think there is more room for that to fall in the future?

Jon Jaffe

This is Jon again. I think as we came out of the first quarter and we saw our sales pace pickup from 2.8 sales per month to 3.7, we found we didn’t have to use any additional incentives to achieve that sales pace and to maintain our margins. And we will continue to operate that way on a community by community basis. And it’s as expected, the market continues the slow and steady growth. You should expect that our incentive should be in that range.

Adam Rudiger - Wells Fargo

Okay, thanks for taking my questions.

Operator

Our next question comes from Dan Oppenheim of Credit Suisse. Go ahead. Your line is open.

Dan Oppenheim - Credit Suisse

Great. Thanks very much. I was wondering I guess first in terms of the comments there on margins for the third and fourth quarter, is some of that driven by sort of the changes also in terms of backlog conversion and sort of some operating leverage there or is there an expectation that sort of absent those issues just that margins will be higher in the fourth quarter than the third?

Rick Beckwitt

This is Rick. We generally throughout the year see a progression in our margins from Q1 to Q4. Some of it has to do with what has been left in backlog that hasn’t converted as you pointed out. Typically as we move through the year we can push pricing, but our ability to raise prices is starting to slowdown given that the significant ramp up year-over-year in ASPs.

Dan Oppenheim - Credit Suisse

Okay, thanks. And then I guess the second question would be, we've have heard some other companies talk about somewhat favorable trends in March or relatively favorable for a bit of slowing in April and May, is that consistent with what you saw as the quarter went on?

Rick Beckwitt

With regard to sequential improvement, April was our least. It was sort of the slowest month, but not dramatically different than March and May. May was the strongest month on a year-over-year basis.

Dan Oppenheim - Credit Suisse

Okay, thank you.

Operator

The next question comes from Stephen East of ISI Group. Go ahead sir. Your line is open.

Stephen East - ISI Group

Thank you. Congratulations guys. Stuart, you talked a little bit about balancing out pace versus price. And if you look at what’s going on in some of the demand trends regionally, Houston jumps out at you, Southeast Florida and California. I was wondering what was going on in some of those key markets from a demand perspective and how you all are looking at pricing? Has pricing gone too far? I noticed three of your regions were down quarter-over-quarter on pricing. So, just trying to understand those relationships?

Stuart Miller

Let me start and then I will ask Jon and Rick to kind of jump in also relative to specific markets, but overall Steve, I’ve said a number of times that I think it’s really relevant that rental rates continue to run higher than fully loaded monthly payments on for-sale product and rental rates have continued to move up. So, there seems to be kind of a push on pricing across kind of the platform. And it’s moving in fits and starts a little bit as you go through the course of the year. And so it’s really incumbent on us and other builders as well to just carefully manage and stay close to the market as it relates to balancing pricing and pace.

As noted, there is not a lot of land available to replace communities that are depleted. So, as rental rates are moving, it’s kind of dictating a little bit, where pricing is going on the for-sale side of the business. The for-sale side could probably ramp up volume a lot more, if it held pricing back, but the replacement of communities is very difficult. Land values as you know are stronger than they have been, so that balance of pace and price is a very local matter, each market is a little bit different. But if you take kind of a 30,000 foot view the general trend is still towards the upside.

Jon Jaffe

And this is Jon, Steve. I would add that even within markets, sub-markets can be very different and we do watch this balance very carefully community by community. But as you noted our California was up both in – our growth in community count and sales pace and margin and that market has definitely felt stronger during the quarter than some other markets. Florida, Southeast Florida was also up in average sales price year-over-year, not so much in community count. So we just managed those differently based on what we see in the marketplace, based on what we are bringing online. And also the overall market growth in the community count. So for example Phoenix which we all know was softer had tremendous community count growth in the overall marketplace with sort of flattish activity and that’s why you saw sales pace drop in the Phoenix and accordingly you didn’t see any price appreciation there.

Stephen East - ISI Group

Okay. That’s helpful. And Stuart you mentioned about land buying and it makes it a bit tougher. As you look at your house price appreciation stagnates in all of that, what are you seeing as the implications on the land side and what you are seeing that pencils that type of thing and are you now at the point where entry level land is becoming more and more of a focus as you move forward?

Stuart Miller

Well, look I think you always have to keep in mind that land value is a residual of what you can build on it. Land values don’t really just move aggressively on their own, sometimes they get ahead of themselves just like any other pricing mechanism. But at the end of the day it’s all a residual calculation of what you are going to be able to build on the land, what market is going to desire a particular location that’s going to drive what products you build on the land and what you can afford to pay for it. And ultimately land prices find their way to that kind of equilibrium. So on a market by market basis and within markets in particular locations land prices move sometimes with momentum and pull back a little bit. It’s been my experience and I think it’s the experience in the marketplace today that we are able to continue to purchase land for a product that is going be able to be built on that land. And whether it’s for first-time buyers maybe a little farther out from the best locations or whether it’s for the move-up buyer in the A locations, it really comes down to a residual calculation. Rick maybe you could add some color to that.

Rick Beckwitt

Yes, I think in your response – the other thing I would point out Steve is that we continued to be contracting and tying up parcels one year, two years out, so we still have the ability to buy on a wholesale basis. If you look at our land cost as a percentage of ASP it stayed relatively constant in that 20% to 21% of sales price which allows to have a really strong margin. We noticed in the quarter that our land development spend increased pretty significantly on a year-over-year basis. And that’s really the – that’s really evidencing the fact that we have got some land and we tied up or moving that through the process right now which gives us a lot of confidence that our margins are going to be holding up pretty good.

Stuart Miller

At the end of the day as you see home prices move up you are probably seeing land prices move up. If land prices move up with a little bit more momentum and home prices stagnate those land prices are going to drift back downward ultimately as well. So I think that our margins able to still strive even as home prices might not be accelerating quite as much as they were.

Stephen East - ISI Group

Okay. Thank you. I appreciate that.

Operator

Our next question comes from Eli Hackel of Goldman Sachs. Go ahead sir. Your line is open.

Eli Hackel - Goldman Sachs

Thanks. First question just wanted to focus on multifamily for a minute, pipeline continues to grow pretty aggressively, you said you would be able to be a little bit more consistent I guess in the second half of next year. I was wondering what was driving that, were you able to find the long-term land partner, are these buildings already sold and that what gives you the confidence. And I just wanted to confirm I know in the past you said you are able to generally get maybe 150 basis point spread from the build to self cap rate, is that still generally the case?

Rick Beckwitt

Yes. This is Rick. I think what gives us the visibility in the consistency of the earnings going into the back half of 2015 really stems from when we started our communities. As Stuart highlighted in his opening remarks today we have about 17 communities that are either complete, two of which are completed the rest of which are under some stage of construction. As we look at the balance of this year we will probably start an additional 20 communities plus or minus and that gives you the sort of a runway with regard to how long it takes to build, lease them up and stabilize and then potentially sell them. So we know when we have started and we will see where the lease up progression is and that allows us to really track the building cycle and when we can sale up.

Stuart Miller

Let me add to that and say, I think about our apartment business as kind of a manufacturing plant. It has a fairly long lead time in production and the startup period which we are going through now takes probably 2.5 years to from start to stabilization and sale of an apartment community. The startup period has been a couple of years in the making. We are just getting to the point where we’re delivering our first few coming off the assembly line. And as we get to the back half of 2015, we started to have enough product that has been started is in the pipeline and is moving through in orderly fashion to where we are going to be able to refine the visibility that we can bring from this part of our company. Now the long lead time in today’s market where rental rates have been moving up fairly aggressively and it seems like they are going to continue to really reflects on our initial underwriting having been low and our execution likely to be very strong.

Rick Beckwitt

And the second part of your question was yield on cost versus exit cap. We are still targeting that 150 basis point to 200 basis points.

Eli Hackel - Goldman Sachs

Great, that’s extremely helpful. And then just quickly one follow up Stuart just want to get your latest thoughts on lending standards and maybe what you are seeing over the past couple of months suppose maybe now what’s speeches you have talked to some of friends in the banking sector?

Stuart Miller

Lending standards are still tight. It’s going to be interesting to see how the change in leadership at the FHFA is going to actually translate to the market. We still have the stickiness I think of a banking and mortgage banking industry that is having difficulty getting over the penalty phase of the downturn that we have endured and that penalty Phase is really relevant and because to the extent that people see or they put back risk is great and really political and social risk is also great meaning reputational risk it’s hard for the lenders to get back in the business lending on a rational and reverted to normal kind of underwriting standard.

I have listened to a number of people speak recently from various parts of the government and there is this kind of consistent reframe that we need to loosen mortgage standards. But we don’t want to go back to the excesses of 2006. Every time I hear that we don’t want to go back to excesses of 2006, the fact that they throw that caveat in there is reflective of the fact that they don’t realize just how far field we are from that. And that reversion to normal is indeed even close to them. And so I feel that that’s still an impediment to a big move and opening up liquidity in the mortgage market. I think it’s going to be a slow after margin adjustment that’s going to take place over time. Now on the negative side, it means it’s going to be difficult to really liberate the first time homebuyer and get them back into the marketplace. On the positive side relative to us, people need a place to live and our rental program still looks very attractive to us.

Eli Hackel - Goldman Sachs

That’s extremely helpful. Thank you very much.

Operator

Our next question comes from David Goldberg of UBS. Go ahead sir. Your line is open.

David Goldberg - UBS

Thanks. I appreciate guys taking the call and good morning. I am – I wanted to ask a bit of a theoretical question, I guess and it’s delving a little bit into the comments that you made, Stuart, about being well-positioned for when the entry level comes back and having the right land position to meet that buyer segment? And what I am trying to figure out is there is so much uncertainty about what the entry level coming back is going to look like? And I am trying to figure out how you underwrite land positions accordingly. I mean, we don’t know what price is going to look like, we don’t know what absorptions are going to look like. And so I am just trying to get an idea as you do buy new land that focuses on the entry level where you don’t necessarily have great comps in kind of nearby communities, how do you think about risk control in that environment?

Stuart Miller

I am going to turn this over to Rick and then Jon, because they have in their areas really crafted our land strategy. And we have navigated these waters pretty well to-date thinking about where the market is going and crafting a land strategy to that. And likewise, relative to a first time homebuyer strategy, I think that they have been completely on top of this and thinking it through comprehensively. So, Rick, why don’t you start?

Rick Beckwitt

Okay. It really has to do with price and affordability and commuting corridors if you will. We have taken a very, not aggressive, but thoughtful path in tying up a bunch of property that we could ultimately build on. So, most of the stuff that we are talking about is smaller, it’s money deposits where we have tied up parcels of land, some of which is finished, some of which is would need to be developed with an aim towards building relatively low-priced homes in those markets for the first-time buyer. We know where the commuting path will be. We have a good idea of how far they want to drive. They aren’t in the heart of where our current communities are, because the land isn’t priced accordingly. And we have just done a lot of market research to see where things would comp out and appraise and more importantly focused on what we need to put into the homes to construct them at a price to sell them to them at a good value, but that’s essentially what we have been doing.

Jon Jaffe

And then in the West, David, it’s a strategy really leads us to the product that we have been focusing on, because the price of the land tends to be a lot higher. There isn’t the quick availability, like Arizona, Texas, where the strategy is well-executed that Rick articulated for that land. So, that the market, the thick part of the market is really the move-up market today and that’s where our land buying strategy has been focused. And we keep a very close eye on the tertiary markets, which will feed that first time buyer market as to what’s available and how to bring it on, but we are not really taking the risk today and until that market presents itself as more viable.

Stuart Miller

So, I think what you heard in my comments is we are fully aware that there is a first time homebuyer market out there that is waiting to be able to be activated. It is dependent on mortgage lending standards opening up kind of reverting to normal. We have recognized that once it’s activated, it is a market that has a great deal of pent-up demand. We also recognized that today’s millennial generation has not yet quite defined itself. Is it going to be focused on something that’s more in the middle the city focused or are they going to be building their family by getting married and having children maybe a little bit later in life, but nonetheless still looking for suburban lifestyle. We have developed a land strategy that’s really crafted on creating as much optionality for ourselves in that space as possible looking at different alternatives and preparing products for when that market presents itself. But with that said we are focused on a current basis on the deepest, thickest part of the market which is the first time move up and regular move up buyer and we stand ready to address the first-time buyer as they are activated.

David Goldberg - UBS

Thank you for the color. That’s very helpful. As a follow-up I was wondering if you guys can talk about cycle times and I guess the question as you know with the weather-related delays and some of the push in closings to fourth quarter, are you finding opportunities to cut cycle times in more of a flat market now relative to where we were – when we were maybe growing a little bit more quickly?

Jon Jaffe

Hi, this is Jon, David. I don’t think that the weather really affected cycle times, it did push things out. I would say what we are seeing as the markets mature is cycle time is flattening. In some places we are able to improve it a little bit and in some places it might slide a little bit. Labor, varies by market as well and most of our markets labor is stabilized which allows us to stabilize the cycle time and in Texas we have seen a lot of activity, labor is tighter and so it’s a little bit harder there. So really the market by market issue is a big focus of our company, cycle time from a perspective of the quality of the home and the quality of process for our homebuyers. And we are trying to find ways to be more efficient, but in general I would say it’s just pretty stable out there.

David Goldberg - UBS

Very helpful. Thank you.

Operator

Our next question comes from Ivy Zelman of Zelman & Associates. Go ahead. Your line is open.

Ivy Zelman - Zelman & Associates

Thank you. Good morning guys. Good quarter. Stuart you talked about the demographics and short-term strategy with multifamily being obviously another say tool in your tool box and I believe you told me at one point that maybe Rialto you had several hundred units that were single-family rented, I am wondering what your view on single-family rental is given the more cautious view you have of the renting environment normalizing and whether or not that would be an added part of your growth strategy going forward as you appreciate the deficit in shelter?

Stuart Miller

Well, first of all yes. We probably had single-family rentals through our Rialto, distress portfolios before the rest of market really focused on it. And we had a real opportunity to look at how scattered single-family homes would rent and how they would be managed and of course that business has taken off and it’s been a very successful part of some large fund managers operations and programs going forward. I still think that there are complications in managing a diverse array of products and buildings that are located in scattered locations. But given the fact that we have a long-term production deficit in this country in terms of the amount of homes multi and single-family homes that have been delivered over the past few years since we went into the downturn and we kind of estimate that that’s about $4 million in deficit over the past few years.

It seems to me that all product types high tide is rising out both all product types are going to continues to do okay and be pretty strong simply because there is a demand for places for people to live and there is a scarcity of that shelter. So the single-family rental opportunity is a good one. I think it’s difficult to manage. But it’s highly, highly desirable for people who are growing families and need a place to live. The desire to live in the single-family dwelling is very attractive and the inability to get a mortgage augers in favor of renting versus purchasing. So even with the difficulty of management that business is strong.

Our apartment business we think is a very strong business. It’s easier and efficient to manage. We think that our bottom line is going be very strong. And whether there is an opportunity in the future to do single-family for rent is something that we have looked at, it’s something that we are considering and we will see as we go forward. I think a little bit of that and the answer to that will depend on how the mortgage market evolves in the near-term. You know that it’s my view that it’s evolving fairly slowly. I know that there are those including yourself, Ivy that think that it might be coming on a little bit faster. And I leave a lot of room for that to possibly play out more the way other see it than the way that I see it, but if it doesn’t, then I think the single-family development for rent might become a part of our program going forward.

Ivy Zelman - Zelman & Associates

Great, that’s very helpful. I guess my second question really pertains to the level of incremental supply that’s coming through the top MSAs, where you compete and maybe Jon or Rick can comment on this question? There has been a lot of concern about the level of supply in Phoenix and the pressure that we have seen given the softness in sales and level of pricing pressure. Are there other markets that you think are at risk or do you think there was more of anomaly that Phoenix had some specific drivers that mitigate that in other markets sort of similarly following, I know Stuart you have commented very, very eloquently that there is a very significant deficit of supply, but we do have a lot of growth from the industry as they have loaded up their pipelines with developed lots that they are now going to be opening double-digit increases throughout the builder community for new stores. So, are there any markets that you think that will be following Phoenix’s slowing?

Stuart Miller

I think Phoenix was somewhat of an outlier, Ivy. In that, you had as you know significant price appreciation in the prior year and it led to a lot of activity of bringing new communities online at a time where that price depreciation couldn’t be sustained and volume did not pick up as expected. And I think there are some political factors in Arizona that affected that as well that slowed down job growth from where we thought it was going to be. Don’t see those kind of dynamics in other places. And in the West, it’s not so easy to bring land on fast. I really don’t see that, in Texas, where you can bring land on a little quicker, the absorptions are really kept pace and the job growth is really strong. So, I think in a market like Texas, they don’t see that risk either.

Ivy Zelman - Zelman & Associates

Can I sneak in one quick one just on absorption pace, you said 3.7, I think you said slow and steady recovery, Stuart. What’s the right – what would be this right number for us to think of a normal pace per community, because we used to think 3.5 to 4 was normal?

Stuart Miller

Yes. I think historically 3.5 to 4 is kind of the normal zone, but I think that 1.5 million starts per year is the normal zone also and there are lot of normal historical patterns that we are not seeing right now. I think going back to your prior question and answering this one as well, I think we have got to think in terms of ebb and flow in the market – in the market that we are in. We are going to see markets that get a little ahead of themselves. Pricing is an area that starts to move very quickly and you end up with sticker shock that can be coincident pricing and interest rate sticker shock as interest rates move back and forth. Purchasers in certain markets might find that they want to purchase, but they just can’t get over the sticker shock for a period of time. I still think that the dominant theme is production deficit. And over time, I think there was going to be an evening, a reversion back to some of the more normal trends like a 3.5 to 4 homes per community per month absorption rate, but I think that we are still going to see it ebb and flow as markets kind of find their way to slow steady recovery, but pricing gets ahead of itself or desirability falls off for a period of time. And we will just have to kind of wade our way through some of these numbers.

Ivy Zelman - Zelman & Associates

Okay, thanks guys.

Operator

Our next question comes from Jade Rahmani of KBW. Go ahead. Your line is open.

Jade Rahmani - KBW

Hi, thanks for taking the questions. Do you expect the pace of year-over-year orders growth to pickup in the back half since comps get somewhat easier than what we have seen in the first half?

Stuart Miller

We would expect that would likely be the case, Jade, but we’ll have to wait and see how the market unfolds.

Jade Rahmani - KBW

Okay, thanks. Switching to Rialto, I just want to find out if you could comment on the timing of recognizing the carried interest into income? And also if you could comment on what drove the sequential pickup in joint venture income?

Stuart Miller

The carried interest, Jade, we would expect to be able to book that once it’s served in, which is when it comes in, which we still expect on Fund I to be out in the 2016 timeframe at the earliest.

Jeff Krasnoff

Yes, this is Jeff. I would confirm that 2016/2017 before they start coming in. And then what drove the joint venture income was the fair value in the funds, that’s coming from our real estate funds primarily. So, each quarter we go through a fair value and whatever that increase in value is, is booked through the equity and the earnings line.

Stuart Miller

Yes. And the fair value includes actual operating earnings as well from the ventures. So, it’s really the bottom line of the ventures and it’s our share of the – as a limited partner in those ventures and we had a good couple of quarters.

Jade Rahmani - KBW

Okay. So it’s essentially your 15% interest in the funds?

Stuart Miller

Yes, it’s less than that. It’s about 11% in the first fund and about 8% in the second fund.

Jade Rahmani - KBW

Okay, thanks a lot.

Stuart Miller

Thank you. And in difference of those who want to watch the soccer game, I think it starts at noon, doesn’t it? I think we will take one more question.

Operator

Thank you. Our next question comes from Nishu Sood of Deutsche Bank. Go ahead. Your line is open.

Rob Hansen - Deutsche Bank

Thanks. This is Rob Hansen on for Nishu. You mentioned limited land availability in the release and so I wanted to see if you could walk us through what you meant by that? Is this in specific geographic areas or is this like infill or are you talking about developed lots, some further clarity on that would be great?

Stuart Miller

Sure. I think that it’s been well-documented that as we went through the downturn, just like the homebuilders were impaired, every land developer or land purchaser found their positions to be impaired and the downturn basically shutdown all entitlement and development activity. And of course, you don’t just restart that engine development and entitlement take years, especially in your most desirable markets. It actually takes years and it takes capital. So, there has been some land that has come back to the marketplace, but the entitlement process and the development process has been very slow to start. Those that are well-capitalized can engage these processes, but there have been fewer groups, primarily the large homebuilders that do have the capital to undertake undeveloped land and get that land position for actually getting building permits.

Smaller landowners, historically, active developers have not been able to get engaged in the financing market and therefore have not assumed their traditional role of developing land that’s available for builders to be able to build. So, land continues to be tight across the country, particularly in the markets where land entitlement is most constrained as places like California, places like Florida, the entire Eastern seaboard number of places, it’s very hard to get land activity up and running again. And that’s what produces the constraint. And the land of course that is available and is developed or entitled becomes much more expensive, because there is a shortage and a need to build in some of those areas.

Rob Hansen - Deutsche Bank

Thanks. And one other question I had was since you guys are uniquely positioned to be, you have the single-family and the multifamily perspectives, what are your thoughts on the share of multifamily as a percentage of overall starts going forward? As firstly we kind of meet a mid-cycle level call it maybe 1.5 million in a few years, do you think that the multifamily side is going to have a greater share than in prior cycles or do you think that kind of what’s going on now with rents rising at a fairly rapid pace that’s going to kind of die out at a certain point and then you were going to have a much of kind of a normal single-family percentage of total starts kind of call it mid-cycle?

Stuart Miller

I think it’s an interesting question and we are all going to have to stay tuned. Right now, multifamily is making up about a third of all starts, which is an historical high, but realistically, multifamily is operating or trending to exactly its traditional zone of 300,000 to 400,000 starts per year. It’s just that single-family is awfully low right now. And so we are as an industry we are going to have to wait and see a lot of it depends on how the mortgage market evolves and whether it begins to enable the buyer to come back to the market, especially the first time buyer to come back to the market.

As things stand right now, if you think about the math we have trended in homeownership from a high of 69.2% homeownership rate down to something like a 64.7% homeownership rate. And every 1 percentage point move in homeownership rate translates into 1.3 million households either doubling up or looking for a rental. So, we have shifted a lot of demand away from for-sale and into the rental housing market. Some have articulated the belief that the homeownership rate will continue to fall. There are some outliers that say that it could fall as low as 55%, I don’t believe that, but whether it continues to trend the percentage point of the time, we will have to wait and see, but that will define the percentage of total starts that are multifamily or primarily rental versus for-sale.

Rob Hansen - Deutsche Bank

Thanks. We appreciate the perspectives.

Stuart Miller

Okay. Alright, well, thanks everyone for joining us for our second quarter update. We look forward to joining you again for third quarter results.

Operator

And this concludes today’s conference. Thank you for your participation. You may now disconnect.

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